Sunday, February 16, 2014

We don’t need to choose between flood protection and HS2 and other projects. Just measure their costs and benefits better.

I graduated with a BA (Hons) in Business Studies in 1970 which, to save you the math, is 44 years ago. Virtually everything that I studied on that course is relevant today – indeed more relevant because most of what we learned was unencumbranced with the MBA bullshit that was later to infest this area of study! In the Economics part of the course we covered the subject pretty thoroughly and in a linked area we looked at private and public investment. The latter was particularly interesting as unlike the former social considerations were uppermost.

The social (including environmental and other consequences) impact of private investment projects has been seen to be increasingly important in recent times. That said the main consideration has to be the potential returns over time for private shareholders. They are businesses after all. But for public sector investment it is different. Here return on capital and profit potential are far less important than the total benefits (and costs) of proceeding with a scheme. This is where, on my course all those years ago, Cost-benefit Analysis (CBA) comes in – and it still does. The definition of CBA in Wikipedia seems to express what it is rather well:

“In CBA, benefits and costs are expressed in monetary terms, and are adjusted for the time value of money, so that all flows of benefits and flows of project costs over time (which tend to occur at different points in time) are expressed on a common basis in terms of their "net present value."

The key point about CBA as a tool in project evaluation is that it requires that values are placed on consequences where the effect is not necessarily easy to determine in monetary terms. So, for example, the actual monetary cost of a construction project ought to be forecastable with a reasonable degree of precision. However the social cost of (for example) the disruption during the construction phase is much more intangible and assumptions have to be made. A project that we looked at in some detail was the construction of the Victoria Line in London and the CBA that was carried out on it:

You get the general idea of the approach from this brief summary. Which brings me to both HS2 (the High Speed rail line going North from London) and to capital expenditure on flood protection projects – both very much in the news at the moment.

The first thing to say is that it is intellectually bereft of reason to say that we should either do one or the other of these projects as if capital rationing is such that we can only afford to do one! Nonsense. In an economy the size of Britain's, particularly in the context of a European Union which not only supports infrastructure projects but often part-funds them, every project must be looked at on its own. So this sort of thing in a letter in the Daily Telegraph is drivel:

SIR – Looking at the photographs of storm wreckage along the east coast and up the Thames, it seems that the proposed HS2 money would be better spent on flood defences to prevent the catastrophic flooding of London in the future.

Save London rather than a few minutes’ journey time.

Kate FosterMalvern, Worcestershire

In short if the CBA for both projects is positive then by definition they can be afforded and ought to proceed – all other things being equal. But let me emphasise that it is essential that the cost of intangibles is fairly assessed. For example HS2 involves a huge number of Compulsory Purchase Orders – people and businesses (etc.) will lose their homes to make way for the line. The compensation paid is only part of the cost – what about the social and personal costs to those whose lives are disrupted? They must be properly calculated in so far as it is possible to do this. This does not mean that the line should not proceed – far from it. Every railway line since the early nineteenth century to today has involved disadvantages to those who live on the planned route. But these disadvantages can be assessed, and must be.

In The Netherlands the massive Delta Works were constructed at huge capital cost but the overall benefits unquestionably exceed the costs. Similarly with the Thames Barrier in London. Cost-benefit Analysis techniques helped prove the cases for these projects and they are essential for HS2 and are being used – as you would expect. The same applies to the potential capital projects for the creation of effective flood defences so that, like the Dutch, we actually protect our citizens in future.

My argument here is for more science and more calculation and less emotion. This may seem a tad callous for two projects which really do affect people’s lives and which have oodles of emotion in them. But if we look not at the macro level, where complexities get lost, but at the micro-level where real and intangible costs and benefits can be assessed we have a better chance of actually doing the right thing!